Our IFRS specialists share their views on International Financial Reporting Standards as they are today and as they could be.

Accounting for Cryptocurrency

28 November 2017

What is cryptocurrency?

Before we get out our big sexy accounting books, a quick refresher on crytocurrencies. A cryptocurrency is a medium of exchange such as the US dollar.

There are currently many different types of cryptocurrency in existence. The most popular, Bitcoin, was the first cryptocurrency to appear in January 2009. However, since then the marketing folks have gotten hold of this and we have even funkier names such as Ethereum, Ripple, Litecoin and many more (I’m just waiting for IFRSCoin and then I’m investing!)

Like the US dollar, cryptocurrency has no intrinsic value in that it is not redeemable for another commodity, such as gold. Unlike the US dollar, however, cryptocurrency has no physical form, is not legal tender, and is not currently backed by any government or legal entity. In addition, its supply is not determined by a central bank and all transactions are performed and validated by the users of the system without an intermediary (such as a bank) facilitating these functions. The term cryptocurrency is used because the technology is based on public-key cryptography (for those without a PhD in programming, this just means that the communication is secure from third parties).

If you’re more interested in cryptocurrencies than the accounting thereof, take a look on this link.

So what’s the accounting issue?

The speed, ease and cost savings associated with this type of currency means it has the potential to become the popular choice for payments, with large brands such as EBay, Dell and PayPal accepting Bitcoin payment. Although the function of a cyptocurrency is to improve the ability of parties to transact digitally with each other, to date most investors in cryptocurrencies are investing in them with the hope of realising capital gains. For example, the value of Bitcoin increased approximately 700% between January 2017 and the beginning of November 2017 (now if only I was investing in these things rather than trying to work out the accounting, sigh).

Holdings of cryptocurrencies can be both large and their value can be volatile – so users of financial statements probably want to know about them. However, there is a significant shortcoming: today’s accounting standards are not written with cool cryptocurrencies in mind!

What is wrong with today’s accounting?

Most common sense accountants (yes, there are still some of us left) would agree that the best accounting for a cryptocurrency would be fair value. After all, that’s the value at which investors will either realise their investment or be able to transact in exchange for other goods and services.

Unfortunately ye olde accounting rules haven’t quite moved with the times it seems. In order to be able to measure cryptocurrencies at fair value (sheesh, typing out cryptocurrency is getting tiring, can I just say Bitcoin from now on please, you know what I mean?), the Bitcoin needs to meet the accounting definition of a financial asset. And that’s where the back wheels fall off, because Bitcoins are:

Not legal tender (i.e. cash as defined);

Not cash equivalents because their value is exposed to significant changes in market value; and

Not a contractual right to receive either cash or a cash equivalent.

So Bitcoins fail the definition of a financial asset. Okay, so where does that leave us (other than scratching our collective heads in consternation). Well, today’s accounting rules would lead to accounting for Bitcoins either as an intangible asset or inventories.

If the Bitcoins are recognised as inventory, then they would need to be measured at cost. I guess at a pinch the entity could disclose the fair value of the Bitcoins, but that’s about as good a solution as eating baby food because you have no teeth.

If the Bitcoins are recognised as intangible assets, then the default position would also be to measure them at cost. There is the possibility that if the Bitcoins are accounted for as intangible assets, an entity might be able to justify that there is an active market for the Bitcoins, in which case the Bitcoins would be able to be measured at fair value. However, this is still only second prize, because movements in that fair value would be recognised through other comprehensive income and the gain would not be recycled through profit and loss when the Bitcoins are realised.

Conclusion

Accounting for Bitcoins at fair value with movements reflected in profit or loss would provide the most useful information to investors. However, existing accounting requirements do not seem to permit this.

Accounting for cryptocurrency is not on the agenda of the International Accounting Standards Board. How long do you think it will take before cryptocurrency is a big enough deal that we need a bespoke solution?

This week's guest blogger is Gary Berchowitz, PwC Partner. Connect with him on LinkedIn.

Comments

Hi Valentin - that's an excellent question, I also wondered if that might be the "silver bullet" to solve this. However, I think a broker-trader needs to trade commodities to get FV accounting in IAS 2. Cryptocurrencies are not commodities because they do not represent raw materials or agricultural produce so I don't think that is a possible solution. Cheers.

Obviously cryptocurrencies don't fit to any of currently existing definitions in IFRS. The good thing about commodity trading is that commodity is not specifically defined in IFRS (if I'm not mistaken). Commodity can be considered as something valuable and actively traded in an open market. Cryptocurrencies can meet this definition.
But of course IASB has to react faster.

Great blog post.
Of course, if a company holds crypto-currency (you're right that's not fun to write out) and they adopt the intangible asset viewpoint, under IAS 38, they could choose to account for their Bitcoin (much easier) using the revaluation option. But, under the IAS 38 revaluation approach, accounting for revaluation gains (called revaluation surplus) and losses are not parallel. Gains are reported in equity, unless there were prior revaluation losses. And losses are reported in P&L, unless there were prior revaluation surplus.

With the current volatility of Bitcoin, I'm sure that most companies would prefer reporting gains and losses in a similar manner.
For the record, I teach international accounting in the U.S. We've talked about Blockchain and cryto-currency and I've always taken the simple "fair value" accounting perspective, sort of like accounting for foreign currency transactions under IAS 21. But, as you say, Bitcoin and such are non-monetary, so that approach, though sensible, isn't consistent with the standard. Very insightful. I'll certainly make it required reading for my international accounting class.
Thanks.

1. "Not legal tender" - This depends on legal jurisdiction and can only be assessed on a case by case basis for example:

US:The U.S. Treasury classified bitcoin as a convertible decentralized virtual currency in 2013.The Commodity Futures Trading Commission, CFTC, classified bitcoin as a commodity in September 2015. Per IRS, bitcoin is taxed as a property. In September 2016, a federal judge ruled that "Bitcoins are funds within the plain meaning of that term".

Mexico: Bitcoin is legal in Mexico as of 2017. It is to be regulated as a virtual asset by the FinTech Law.

Japan: Japan officially recognizes bitcoin and digital currencies as a "means of payment that is not a legal currency" (see Article 2-5 of Japans's Payment Services Act (PSA) 25 May 2016).On 7 March 2014, the Japanese government, in response to a series of questions asked in the National Diet, made a cabinet decision on the legal treatment of bitcoins in the form of answers to the questions. The decision did not see bitcoin as currency nor bond under the current Banking Act and Financial Instruments and Exchange Law, prohibiting banks and securities companies from dealing in bitcoins. The decision also acknowledges that there are no laws to unconditionally prohibit individuals or legal entities from receiving bitcoins in exchange for goods or services. Taxes may be applicable to bitcoins.
According to Nikkei Asian Review, in February 2016, "Japanese financial regulators have proposed handling virtual currencies as methods of payment equivalent to conventional currencies".
The city of Hirosaki is officially accepting bitcoin donations with the goal of attracting international tourists and financing local projects.In 2017, the country’s government officially recognized bitcoin as a method of payment.

Germany: On 19 August 2013, the German Finance Ministry announced that bitcoin is now essentially a "unit of account" and can be used for the purpose of tax and trading in the country, meaning that purchases made with it must pay VAT as with Euro transactions. It is not classified as a foreign currency or e–money but stands as "private money" which can be used in "multilateral clearing circles", according to the ministry.

Switzerland: Bitcoin businesses in Switzerland are subject to anti-money laundering regulations and in some instances may need to obtain a banking license.On 5 December 2013, a proposal was put forth by 45 members of the Swiss Parliament for digital sustainability (Pardigli), that calls on the Swiss government to evaluate the opportunities for utilization of bitcoin by the country’s financial sector. It also seeks clarification on bitcoin’s legal standing with respect to VAT, securities and anti-money laundering laws.In response to the parliament postulates, the Swiss Federal Council issued a report on virtual currencies in June 2014.[126] The report states that since virtual currencies are not in a legal vacuum, the Federal Council has concluded that there is no need for legislative measures to be taken at the moment. In 2016, Zug added bitcoin as a means of paying city fees, in a test and an attempt to advance Zug as a region that is advancing future technologies. Swiss Federal Railways, government-owned railway company of Switzerland, sells bitcoins at its ticket machines.

Estonia: The Estonian Ministry of Finance have concluded that there is no legal obstacles to use bitcoin-like crypto currencies as payment method. Traders must therefore identify the buyer when establishing business relationship or if the buyer acquires more than 1,000 euros of the currency in a month.

Luxembourg: The Commission de Surveillance du Secteur Financier has issued a communication in February 2014 acknowledging the status of currency to the bitcoin and other cryptocurrencies. The first BitLicence was issued in October 2015, and the government is actively supporting this development.

United Kingdom: As of 2017, the government of the United Kingdom has stated that bitcoin is unregulated and that it is treated as a 'foreign currency' for most purposes, including VAT/GST. Bitcoin is treated as 'private money'. When bitcoin is exchanged for sterling or for foreign currencies, such as euro or dollar, no VAT will be due on the value of the bitcoins themselves. However, in all instances, VAT will be due in the normal way from suppliers of any goods or services sold in exchange for bitcoin or other similar cryptocurrency. Profits and losses on cryptocurrencies are subject to capital gains tax.

2. "Not cash equivalents because their value is exposed to significant changes in market value" - currency values fluctuate. Was the Zimbabwe dollar not considered cash or cash equivalents? Its value was exposed to significant changes in market value, but I'm sure it is considered a cash or cash equivalents . Did Sterling stop being a cash because of volatility in the days following Brexit?

This is a very well written post - simple & effective. Look forward to see where we head with this with IASB. Before reading through the post, default thought was to think yes, definitely valued at FV - simimlar to FX transactions like Richard above have pointed out. Oh but! the pitfalls of accounting standards. Sigh!

Thanks to John for his comment above, wow it looks like you've really done your homework with respect to legal tender! I actually had a related discussion with a former colleague (@michael gaull) who asked where exactly IAS 32 AG3 stated that cash needs to be legal tender? Based on that discussion and your points above, I think there is perhaps another debate that needs to be had as to whether "currency" defined in IAS 32 AG3 can only represent cash issued by government authorities. I couldn't find any further definitions of currency in IAS 32 or IAS 21 and a good old google and online dictionary search of the word "currency" isn't clear whether this needs to be legal tender. So all that said, that might be a great question for the IFRS Interpretations Committee to answer! Thanks for the post and interest in the blog! Cheers.